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Central banks bring more volatility into the gold space

Commentaries & Views

On Wednesday, the Federal Open Market Committee (FOMC) announced it will raise rates by 75 basis-points as the markets had anticipated, which is the highest level since January 2008 at 3.75%-4%. This marks the fourth consecutive 75 bps raise as the Fed maintains a hawkish approach in its attempt to curb an inflation rate the central bank insisted was "transitory" until higher CPI readings had become entrenched earlier this year.

"The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time," the world's largest central bank released in a statement on Wednesday.

Although the gold price rose sharply up to resistance at $1675 on this expected news, during the press conference Fed Chair Jerome Powell remained cryptic, channeling former Fed Chairman Alan Greenspan's notable line that "If I say something which you understand fully, I probably made a mistake." When asked right off the bat about the next rate hike in December, Powell hinted that rate increases could be less aggressive from now on.

"At some point, it will become appropriate to slow the pace of increases. That time is coming, and it may come as soon as the next meeting or the one after that. No decision has been made," Powell said. "To be clear, let me say again, the question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive."

However, Powell added that even though a slowdown in rate hikes might happen in December or February, the U.S. central bank is likely to take rates higher than previously thought. "At some point.….it will become appropriate to slow the pace of increases as we approach the level of interest rates that will be sufficiently restrictive to bring inflation down to our 2% goal," he said. "We still have some ways to go. And incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected."

Powell also acknowledged that the window for a soft landing has "narrowed" as monetary policy has become more restrictive this year. "The inflation picture has become more and more challenging over the course of this year," he said. "That means that we have to have policy be more restrictive, and that narrows the path to a soft landing."

Interestingly, when Powell was asked about stock and bond markets initially reacting positively to its latest hike, he responded with a series of hawkish statements. The market had already turned lower, but he had no way of knowing this. "I would want people to understand our commitment to getting this done, and to not making the mistake of not doing enough or the mistake of withdrawing our strong policy and doing that too soon," he said.

But for investors, the defining moment during the press conference came when the Fed Chairman told a reporter, "We'll want the policy rate to be where the real rate is positive." Stocks and the gold price dramatically reversed course after this statement, quickly erasing initial gains and sinking lower.

The Nasdaq Composite was the worst hit index, closing 3.4% down on Wednesday. If Powell's aim was to signal a slowdown in rate hikes but prevent a market rally, then he has done so successfully, as unpopular as it may be as we head into the mid-term U.S. elections next week.

Then across the pond in the UK on Thursday, Bank of England (BoE) Governor Andrew Bailey warned consumers that the central bank would continue to raise interest rates to bring down inflation even as the economy continues to cool. The comments from Bailey came during a press conference after the BoE raised its Bank Rate by 75 basis points to 3%, the biggest rate hike from the central bank since 1989.

Although the BoE recognizes that British consumers are struggling in the face of rising food and energy costs and increasing mortgage and borrowing rates, Bailey was much more direct in his comments to reporters with no mention of an eventual soft landing. "We understand the difficulties we are in," said Bailey. "But if we don't take action to bring down inflation now, it will get worse," he said. Bailey also said the upside risk to inflation is the largest it has ever been in the history of the Monetary Policy Committee (MPC).

In its MPC statement, the central bank was also more direct when it warned that the economy could see a two-year recession as interest remain elevated. According to its economic projections, the BoE sees the economy contracting by 1.5% in 2023 and sees a further 1% decline in GDP in 2024.

Despite bullion moving higher from important technical support at $1620 after Bailey's statements, the Fed pushing out an imminent interest rate pivot further has opened the door wider for lower gold prices. A close below $1620 in the safe-haven metal would bring long-term support at the $1550 level into view.

As mentioned previously in this space in late September, the failure to close above $1705 at quarter-end brought the $1550 region into play, which is the 50% Fibonacci retracement after the gold price doubled from $1045 in late 2015, to $2090 by mid-2020.

Moreover, the $1550 level was critical support during the previous bull market which saw the gold price move from a low of $250 in 2001, to over $1900 by 2011. The $1550 region was tested several times during the consolidation of those outsized gains from mid-2011 until March of 2013. And when broken decisively, gold began a sharp decline into a bear market that did not end until late 2015 at $1045 per ounce.

On the upside, initial resistance is at former long-term support at $1675, with stronger resistance at $1740. A close above $1825 would suggest a sustainable bottom being in place.

Meanwhile, central banks globally have accumulated gold reserves this year at a pace not seen since 1967, when the U.S. dollar was still backed by the precious metal. As retail selling in gold ETF's persisted into Q3, central bank demand for gold was up 28% year-on-year, reaching 1,181 tons, according to the latest World Gold Council (WGC) report.

Central bank buying in the third quarter far exceeded the previous quarterly record in data stretching back to 2000, just before gold price began a 6x move into 2011. This took their purchases for the year into September to 673 tonnes, more than the total purchases in any full year since 1967, according to the WGC.

Furthermore, silver and bombed out gold stocks continue to show relative strength to the gold price in their attempts to carve out a sustainable bottom. Silver made its low at the beginning of September at $17.40 and has failed to make a lower low, trading $2 higher, even as the gold price is flirting with losing key support at $1620.

However, resource stock speculators continue to use high-risk junior press releases as liquidity events to sell shares for tax-loss, regardless of assay result content. With tax-loss season ramping up into mid-December, quality junior babies continue to be thrown out with the lifestyle junior bathwater.

With the gold price teetering on the precipice of either a final flush down to the $1550 region, or having already bottomed as the market sniffs out an eventual Fed policy pivot, tax-loss season is a great time to accumulate a basket of quality juniors to buy and hold before the next up-leg in this secular gold bull market begins. If you require assistance in doing so, and would like to receive my research, newsletter, portfolio, watch list, and trade alerts, please click here for instant access.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.